Collect Truly Passive And Growing Income

Co-authored by Treading Softly

I’ve learned in life that there is one constant that exists, and that has never changed in my lifetime. I’ve seen people gain access to the Internet and be able to connect to people from around the globe within seconds. I’ve seen fax machines disappear. I’ve watched as we’ve gone from having carburetors on the top of our engines to intricate computer-controlled engine management systems. Even in my day-to-day life, people have gone from paper books to glowing screens for their average way of absorbing ink and reading content. TVs have gone from being massive in size with tiny screens to having massive screens with tiny backdrops.

Things are endlessly changing.

Yet, even in this landscape of endless change, physical property remains a must. Stores largely tried to become mostly online, and we’ve seen the success of many stores doing so. Still, the largest online retailers have purchased property for their warehouses and even purchased properties for people to pick up their wares from. The “buy online, pickup in-store” trend is strong. We still seek out entertainment from physical locations. It’s hard to go skiing or have a quality spa treatment at home. These are things that you need to go and experience in person. Because of this, I continue to find myself investing in and believing strongly in real estate, especially real estate that involves entertainment that requires in-person attendance, and owning property that is tied to retailers that have excellent foot traffic. I do this by investing in REITs that own properties leased out to these service providers. I would rather not own the company that is exposed to the fickle whims of the consumer; instead, I’d rather own the landlord that collects the rent from companies. This is because companies can come and go, but the property remains essential.

Today, we’re going to look at two REITs that provide me with income generated from the properties they own. Due to the kind of businesses they support, I can look forward to lifelong income from my investment.

Let’s dive in!

Pick #1: NNN – Yield 5.3%

NNN REIT, Inc. (NNN) is one of the older publicly traded REITs. As its name implies, it follows an “NNN” (triple-net) investment strategy. A triple-net lease is a lease that makes most of the property-level expenses the responsibility of the tenant, including property taxes, insurance, and maintenance costs. For the landlord, the appeal is in not needing to manage the day-to-day operations of the property. They also do not take on the risk of property-level expenses rising. For the tenant, a triple-net lease is usually lower rent, and the tenant usually has a lot more freedom to modify or repair the property without having to rely on the landlord.

In Q1, NNN reported AFFO (Adjusted Funds From Operations) of $0.84/share, putting it on track to hit the high-end of 2024 guidance. Source

NNN has a history of slow and steady growth. This isn’t a company that is going to take big swings and try to grow quickly. Instead, it has grown its portfolio with a relatively steady pace of acquisitions. Source

This means that NNN has not experienced the boom and pullback cycle we see with some peers, where they expand aggressively but then need to take years to deleverage to control their balance sheet.

NNN’s approach is to have long-term leases, with an average remaining lease term of 10 years:

What makes it different from most peers is that NNN pairs these long-term leases with long-term debt. While most REITs will take out 5 to 7-year bonds, NNN has structured its balance sheet with 10+ year bonds. It has $1.5 billion (approximately 35%) of its bonds that don’t mature for 24+ years.

By pairing long-term leases with long-term debt, NNN has been able to provide extremely stable returns. This includes dividends that have been raised every year for 34 years, even during several recessions.

NNN is currently trading at a low valuation relative to recent history, at about 12x FFO/share. We can chart its history based on CFO/share – a similar metric.

NNN is pursuing the same strategy it always has. It has a strong balance sheet and is growing at a slow and steady pace. Shareholders can have a lot of confidence that the dividend will continue to rise. NNN is a company we can hold through a recession with a lot of confidence, collect our dividends, and wait for its valuation to return to historical levels.

Pick #2: EPR – Yield 8%

EPR Properties (EPR) is a REIT that invests in experiential properties. It focuses originally on movie theaters but has rapidly expanded to other experiential properties like ski resorts and educational properties. EPR had a quarter in line with management’s guidance and their annual target of $4.76-$4.96 FFOAA (FFO as Adjusted). It is worth noting that EPR‘s earnings were down from last year and are expected to be down for the year. However, this is due to revenues collected last year, which were rent payments that were deferred in 2020. Source

Excluding those excess funds in 2023, EPR expects that 2024 FFOAA will be up 3.2% at the midpoint of guidance year-over-year. The good news is that EPR’s tenants have paid back the back rent owed as agreed. Last year, EPR collected over $36 million in deferred rent. In Q1, it collected $0.6 million, which is the remaining balance. So deferred rent will not be a part of future earnings.

EPR’s tenants have recovered, and even theaters have achieved rent coverage that is the same as they experienced in 2019. The primary reason is that while fewer tickets are being sold, they are making more money on food, beverages, and other add-ons. Source

Diversifying away from theaters remains a priority for EPR, though they are doing it more through buying other types of properties rather than actively selling theaters.

EPR continues to fund investments through recycling capital and retained capital. It ended Q1 with $59.5 million in cash and nothing drawn on its $1 billion revolver. Annual guidance is for net acquisitions to be around $200 million, so it is likely that we will not see EPR make any significant moves to leverage up unless conditions change.

EPR has $136 million in debt maturing in 2024, which management stated in the earnings call that they intend on paying with cash/the revolver. This will buy them time to wait to see if interest rates decline before issuing new debt.

The bottom line is that EPR isn’t happy with its cost of capital, and it is unwilling to issue equity at current prices. Nor is it enthusiastic to be issuing debt at current interest rates. As a result, what we are seeing now is the baseline organic growth that EPR’s portfolio is capable of sustaining, which is around 3%.

EPR is currently yielding 8%, and we can expect it to continue growing its dividend at 3% from here, with some potential for faster growth if EPR’s cost of capital becomes more favorable.

Conclusion

With NNN and EPR, I not only own real estate tied to essential retailers and entertainment properties, but also have an income stream that is set to grow in the future.

You can be a landlord and deal with the taxes, the toilets, and the tenants, or you can earn truly passive income by owning REITs and never have to deal with any of those three.

When it comes to retirement, the last thing I want you to worry about is tenant issues, fixing up plugged toilets, or having extra complicated taxes because of the real estate you own. I want your life to be as simple as possible. There is one reason why I am a proponent of my unique Income Method, to keep things as simple as possible. I’m not coming up with complex trading schemes, dabbling in options, or piling on the margin. Instead, I like things to be as simple and straightforward as possible because I like to lead a simple, straightforward lifestyle. Others can have success with those complex strategies, and if you are, I think that’s wonderful for you. I have found that following the KISS principle, “keep it simple, stupid,” has rewarded me the most in my personal experience. When it comes to retirement, I want a simple life, simple pleasures, and simply not having to be worried about my financial security.

That’s the beauty of my Income Method. That’s the beauty of income investing.